The Controversial Banker

John Crow describes how he wrestled inflation to the ground.

Making Money:
An Insider's Perspective on Finance, Politics and Canada's Central Bank
John Crow
John Wiley & Sons
256 pages, hardcover
ISBN 0470831804

ew present-day Canadians evoke as much controversy as John Crow. In the view of his admirers, his tenure as Bank of Canada governor during the late 1980 s and early 1990 s initiated a landmark shift in Canadian monetary policy and the establishment of an admirably clear set of monetary policy goals that are still followed today. For his detractors, his anti-­inflationary militancy as governor was ideologically motivated and profoundly harmful, with negative effects still felt today.

With these memoirs, Crow has penned his own defence, focusing not just on his time as governor, but on the previous two decades of Canadian policy making. It is a richly anecdotal look at a crucial era, in which he throws off the veil of bureaucratic detachment and tackles his critics in straightforward terms, while placing his own legacy in what he considers to be its proper light.

The institution with which he is identified is relatively young by central bank standards: the indirect product of the collapse of the international gold standard in the early 1930 s. In its mandate and structure, the Bank of Canada owes much to British antecedents. Its basic policy goals have been developed in tandem with governments of the day, although the bank has had considerable practical leeway in exercising its powers. In its entire history, the bank has had just seven governors. The first was Graham Towers, formerly a private bank executive and before that a star pupil of Stephen Leacock's at McGill. With a patrician assurance paralleling that of his famous mentor, Towers steered the bank through the tumultuous period through to the end of the Second World War, and was rewarded with three consecutive terms in office. His successor, James Coyne, lacked Towers's astuteness and was forced out of office by the Diefenbaker regime in a bitter fight over bank independence during the early 1960 s. This fractious period immediately preceded the Canadian government's experiment with fixed exchange rates, when in 1962 the dollar was pegged at a value ( 92 . 5 U.S. cents) that remained in force for the rest of the decade. Coyne's successor, Louis Rasminsky, faced the unenviable task of dealing with gradually increasing inflation—imported from the U.S., thanks to the dollar's peg—with little manoeuvring room due to the fixed exchange rate.

Only after 1970 , when the dollar went back to its previous float, did the bank regain the ability to stem the inflationary tide. Early in the decade, its efforts were stymied by global trends such as rising commodity prices, as well as by domestic government expansionism. When Rasminsky departed as governor in early 1973 , he made it clear how difficult he thought the task of a central banker had become:

In a certain sense, I think it is really impossible to succeed at the job of being a central banker under today's conditions when economic arithmetic counts for so little and all the social and economic pressures favour inflation. [Quoted by Crow]

Rasminsky can himself be blamed (although Crow does not do so) for the bank's seeming lack of direction in the final years of his governorship. In any case, his pessimism was fully confirmed by ensuing events. When Liberal finance minister John Turner gave his epoch-defining 1973 budget speech, he included a remarkably frank statement of the guiding principles that would inform the Trudeau Liberals' fiscal intentions during their remaining terms in office:

We shall be attacked in some quarters for still not doing enough to stimulate the economy. Others will say that we are doing too much and that by over-shooting the target, we will aggravate inflation. We recognize that we are running a risk, and that the risk is on the side of over-shooting. That is a risk worth taking at this time in the interest of dealing more effectively with unemployment.

As Turner's standard-bearing statement makes clear, the aim was to curtail unemployment through expansionary measures, with any inflationary effects to be addressed through non-fiscal means. These were challenging times to be a Canadian central banker, and it was at just this juncture that Crow arrived at the bank to work as a research economist under Rasminsky's successor, Gerald Bouey, in 1973 . An Englishman by birth, Crow had spent several years at the International Monetary Fund. He had a close working relationship with the bank's new governor, which gave him the perfect vantage point from which to observe its response to the high inflation of these years.

By mid decade, the combination of the OPEC oil crisis, the government's “all hands to the inflationary pump” fiscal measures and the bank's indecisive leadership had caused inflation to reach the double digits. Not only was Canadian inflation considerably worse than in the U.S., but it was also exacting a significant domestic toll. Along with a growing realization that something had to be done came the wage and price controls announced in October 1975 —ironically just months after an electoral majority, won with a Liberal campaign centred on opposition to the Conservatives' own proposed controls program. Among professional economists, there was little expectation that the government's program would have much salutary effect. The main inflation attack, it was recognized, would have to come from monetary policy. Unfortunately, the bank at this point devised a policy that was ill judged in the extreme. Monetarist-inspired, the new agenda focused on cutting monetary growth as the key to reducing inflation. For its relevant monetary measure, the bank chose a narrow definition known as M 1 . As it turned out, this definition performed miserably at its assigned task. While the bank met its gradually falling targets for M 1 growth over the next five years, inflation did not drop as predicted. The reason was that chartered banks, realizing that growth in M 1 deposits would be capped, introduced a range of exempt accounts to entice their customers, so that bank deposits as well as spending continued to increase.

By 1981 , with inflation higher than it had been in the mid 1970 s, the bank switched to a new policy and informally pegged the Canadian currency to the U.S. dollar (doing so in a rather complicated and initially unpublicized fashion). As in the 1960 s, Canada's inflation performance was tied to U.S. trends, but now with extremely contractionary results, given the policies of America's newly appointed chief central banker, Paul Volcker. As Canadian inflation proceeded to fall, unemployment soared to rates not seen since the Depression. Crow summarizes some of the ensuing criticism. Most notable was the contribution of the Canadian Conference of Catholic Bishops, which in 1983 released a wide-ranging political tract, Ethical Reflections on the Economic Crisis , that roundly condemned the bank's tight monetary policy. Crow summarizes, in less than adulatory terms, the bishops' perspective:

[They] clearly favoured a highly interventionist, almost syndicalist, approach to national economic management. They sought, among other things, “assurances that labour unions will have an effective role in developing economic policies…” including no doubt a role in developing monetary policy as well. One can perhaps wonder what the bishops thought about representative democracy, better expressed in this instance through the endeavours of the New Democratic Party rather than through trade union actions. But then, their own governance set-up was itself hardly a representative democracy.

More to the point, the bishops' vision of centralized corporatism would be highly unworkable in a confrontational political culture such as Canada's. These cultural propensities were well illustrated by some of the other critics of bank policy. The Canadian Labour Congress, for example, organized mass protests against high interest rates. Meanwhile, a group of 50 left-­leaning economists issued a statement highly critical of bank policy. Crow provides another set of withering comments in summarizing their proposals:

These economists considered that the thing to do was to lower interest rates “by 2 to 3 percentage points” and not worry overmuch about where the Canadian dollar went. They also were keen on a broader incomes and prices policy—“preferably through negotiations with business and labour”, another triumph of hope over experience that could only occur in the cloisters of academia.

The problems inherent in the Group of 50 's proposals could be judged by the ineffectiveness of the Liberals' earlier flirtation with wage and price controls. While inflation had fallen in the initial year of the program, this was largely due to changes in food prices, which were exempt. The rate had then inched back up during the program's duration. To reduce inflation significantly, much more draconian controls would have been required, and such rigorous methods would have had their own harmful effects, by severely constraining market activity.

The unavoidable truth has always been that inflation hurts, and so does anti-inflationary policy. Crow saw this lesson confirmed as he watched Bouey (whom he personally admired) fend off a host of political attacks in the aftermath of the 1981 – 92 recession. As the economy improved during the middle of the decade, however, Bouey's battling instincts waned. Inflation was allowed to persist at a relatively stable level, albeit at much lower rates than before the bitter medicine of the early 1980 s. Crow was in quiet disagreement with Bouey's approach, as he made clear once he took over the reins as governor in 1987 . Early on, he outlined his intentions in a lecture at the University of Alberta. Under his watch, he said, monetary policy would aim to achieve price stability as its overriding goal, because the experience of the previous two decades had shown the minimal long-term impact of monetary expansionism on unemployment. Over time, inflating the economy to reduce unemployment was bound to fail.

Crow's reasoning here reflected the emerging consensus within macroeconomics. More distinctive than his statement of general goals, however, was his practical corollary: maintaining inflation at some stable level, as Bouey had done in his latter years as governor, was misguided. Stable inflation could never substitute for a stable price level, because if inflation happened to rise for some reason, there was nothing to stop the bank from living with the new higher rate. In such circumstances, the public's faith in money as an inviolable standard would necessarily be compromised.

This new thinking, backed up by an extremely tight policy regimen, prompted a new round of attacks from bank critics. No longer were the neo-syndicalist Catholic bishops part of the chorus (by this time, they had more immediate ­concerns). But joining the reform-minded commentators was a large group of mainstream economists. As far as this latter group was concerned, Crow's doubts about the long-run viability of stable inflation might be perfectly valid, but these doubts did not warrant a further reduction in inflation, with all the attendant short-term damage to the Canadian economy.

Crow was unmoved by these demurs. Short-term interest rates stayed in the double digits through 1989 , even as corresponding U.S. rates began to fall. A brief monetary loosening in the early months of 1990 was quickly reversed, and the bank kept its policy relatively tight during the ensuing recession. Meanwhile, Crow started negotiations with finance minister Michael Wilson over a new long-term monetary goal. Now the focus was on targeting inflation itself. At this time, only one country (New Zealand) had adopted formal inflation targets, and Canada would become the first major industrialized country to do so. The bank's staff had already investigated this possibility before discussions began with Wilson. But, according to Crow, it was the Department of Finance, spearheaded by Wilson himself, that initiated the proposal that would be jointly adopted by the bank and government in early 1991 . This proposal called for so-called “core” inflation to be brought below two percent within a relatively short period, and then kept indefinitely between zero and two percent.

Crow's statement of Wilson's central role in initiating inflation targeting, which he makes public for the first time in these memoirs, has interesting ramifications. It extends the list of economic policies (including continental trade liberalization and a focus on deficit reduction) that the federal Liberals adopted, either directly or indirectly, from their Conservative predecessors. Of these three crucial planks in Canada's current policy mix, however, inflation targeting was the one that the Liberals showed the greatest reluctance in adopting, as Crow's subsequent narrative reveals.

During the 1993 federal election campaign, the Liberals firmly opposed the bank's anti-­inflationary polices, as expressed in rather garbled form in the party's Red Book. Crow spares no quarter in criticizing this publication. After quoting the relevant Red Book promise (“a monetary policy that produces lower real interest rates and keeps inflation low, so that we can be competitive with our main trading partners”), Crow comments: “Was this a joke? I don't think that anyone with a decent understanding of monetary policy matters could have made this up if they tried.”

Whatever the Liberals had in mind, their view of monetary policy did not initially include reappointing Crow as governor. “While my seven-year term of office was due to expire at the end of January 1994 ,” says Crow, “I was never asked whether I wanted to continue, although my silence on the matter was probably (and reasonably) taken by both the Bank's board and the incoming government as evidence that I might be prepared to stay.” But in mid December of 1993 came an unexpected proposal. Realizing how ill conceived it would be to dispense completely with inflation targets, the new government was willing to compromise. In return for his reappointment as governor, Crow would have to agree to amend the inflation targets from the previous range below two percent to between one and three percent. Crow refused, effectively ending any chance his term would be extended.

To outsiders, this might seem a minor point on which to take a principled stance. But for Crow the disagreement was a major one. He still strongly believes that the one to three percent range that has since become official government policy (and which the bank has consistently met right up until the present day) does not represent real price stability: it is the chimera of low but stable inflation that he attacked early in his tenure as governor. In contrast, the Liberals are concerned with distinguishing their own monetary policy program from the one they had so strongly opposed in the 1993 campaign. Just as important, they tend to subscribe to a set of theoretical arguments within mainstream economics that cast doubts on the validity of Crow's call for true price stability.

In his memoirs, Crow refers to these arguments in general terms. The first, which has many eloquent proponents within the economics profession, presumes that there is an important benefit from a low but stable rate of inflation, due to the way inflation can aid wage movements. A little inflation can be a good thing, this argument suggests, if it means that real wages can move both up and down, depending on how money wages change relative to prices. Not surprisingly, Crow thinks very little of this theoretical ­perspective, known in technical jargon as the lubricant hypothesis.

Just as important in the new government's thinking—especially during its early years in office—were issues surrounding public debt. These were quantified in the empirical work of Quebec-based economist Pierre Fortin, who purported to show that high interest rates, combined with consequent low economic growth, were the main reason for the vicious cycle of higher interest payments and budget deficits that afflicted the Canadian economy during the early 1990 s. In his memoirs, Crow mentions the difficulty in isolating monetary policy's impact from other trends, such as the global business cycle. He also cites the Canadian economy's performance in more recent years. Given how Canadian interest rates have plummeted over the past decade, the temporary vicious cycle Fortin identified has been transformed into a potentially permanent (and therefore much more powerful) virtuous cycle of lower interest payments and budget surpluses. Any short-term harm from bringing down inflation has therefore been far out-balanced by the long-term gains that have flowed from the policy.

This relative weighting of the costs and benefits of low inflation policy has often been ignored or downplayed by Crow's critics, but it is absolutely essential in assessing his legacy. Canadians are reaping significant benefits from the country's current stellar macroeconomic performance. While it is usual to attribute this performance to the federal Liberals' past enthusiasm for deficit cutting, this merely reflects the greater popular attention accorded to fiscal rather than monetary policy. In fact, Crow's anti-inflationary actions were just as important (if not more so) in erasing the risk margin formerly built into Canadian long-term real interest rates. His actions were also vital in spurring the sea change that has recently taken place in Canada's balance of payments position, as the decades-long current account deficits and capital account surpluses have been reversed, allowing for the opportunity for a sustained reduction in the country's net international debt for the first time in the country's history.

In line with these achievements, there is a general consensus, at least within specialist circles, that there should be no return to the ad hoc approaches of the past. Inflation targeting is here to stay. And no matter what role Michael Wilson might have played in initiating these targets, it is widely recognized that it was Crow, more than any other person, who ensured they were achieved. But many economists still disagree with Crow that a zero to two percent inflation target range would be optimal. (Indeed, some, like Fortin, would prefer a two to four percent range rather than the current one.) Not only are theoretical arguments such the lubricant hypothesis part of such thinking, so too are worries over the inherent statistical biases in the calculation of the inflation rate. (The bank's own estimates suggest that the published statistic systematically overstates actual inflation by about a percentage point each year.)

Despite such cavils, there is widespread admiration within the economics profession not just for Crow's theoretical consistency, but also for his willingness to set out forthrightly in these memoirs the details of his years as governor. The narrative is not just of considerable professional interest, but has fascinating personal aspects as well. Most notably, satirical descriptions, such as what Crow calls the “Pauline conversion” behind the landmark 1995 federal budget, make it obvious he bears considerable animus toward Paul Martin. This animus is mixed with more than a hint of frustration at the electoral rewards that will likely be reaped by the Martin-led Liberals in what is effectively Canada's new one-party national government, thanks in part to the economic benefits that have flowed from the hard choices that Crow himself made.

Given this frustration, it is not surprising that Crow should hint who he thinks is the best prime ministerial candidate among the current contenders. “Mr. Manley, now Canada's deputy prime minister, minister of finance, and a few other things as well to occupy his time,” Crow notes at one point in his narrative, “stood out as the most able tenant of that position [finance critic of the Official Opposition] during my term as governor.” No doubt John Manley appreciates the compliment, although he would never admit as much given the lingering dislike of Crow within Liberal ranks. If Manley does one day become prime minister, there is a good chance that his conservative economic bent will mean that Crow's desired zero-to-two target program will finally become a reality. At that point, Crow will have the satisfaction of knowing that his legacy is complete. Indeed, the profound contributions that he has made to Canada's long-term macroeconomic prospects may also finally gain the public recognition they so fully deserve.

Mark Lovewell